Is the RBA done-and-dusted?

As predicted by QIC and all but 3 of our 32 fellow panellists on the Bloomberg’s panel of expert forecasters, the RBA delivered a 25 basis point Cup-Day rate hike. The question now is, “is the RBA done-and-dusted?”

To us and the market, it does indeed look like they’re done. But the RBA retains a slight tightening bias and that leaves the door open for another rate hike.

What could push the RBA into another hike and what would be the timing of another hike, if it were to come? In our view, there is one, and only one reason the RBA would undertake another rate hike and that is a lack of progress in getting inflation down. And, if the RBA formed that view, the most likely timing of another rate hike would be their February meeting next year; their first meeting in 2024. So, what could trigger enough concern on the progress on inflation to drive the RBA to another hike?

First, the risk that the underlying rate of inflation remained stubbornly sticky. A key indicator of that risk is wage growth and the degree of tightness in the labour market.

Here, landmark data points will be the September quarter outturn for wage growth released this coming Wednesday, the monthly labour market reports (with October’s report due Thursday) and the December quarter CPI release (due on the last day of January next year; about a week before the RBA’s meeting on February 6th). For the RBA to go again, we would need to see upside surprises in these key releases.

That would mean an annual rate of wage growth for the September quarter north of 4%, the unemployment rate failing to make progress towards 4% by year end, and underlying CPI for the December quarter north of an annual rate of 4.5%. What about the prospects for monetary policy if we get through the remaining months of 2023 without the RBA coming under pressure to raise rates?

Currently, the market expecting is the RBA to remain on hold throughout 2024. And the market is probably right. Why so? At the end of next year, inflation will still be above the RBA’s target band of 2%-3% and the unemployment rate will be just hitting the RBA’s neutral rate of 4.25%. These outcomes will not be enough for the RBA to cut rates over 2024.

When the RBA eventually does cut the cash rate, where will they land? Of course, this depends partly on the stage of the business cycle the economy finds itself in when rate cuts are being undertaken.

Assuming for the moment that the economy’s growth rate is at trend, the unemployment rate is at the RBA’s target of 4.25% and inflation is at the RBA’s target of 2.5%, then the RBA’s historical guidance would have the cash rate at 3.5%; its current estimate of the so-called neutral cash rate, otherwise known as R*.

But this estimate of R* was made during the decade between the GFC and Covid, when quantitative easing (QE) by the world’s main central banks (including the RBA) was suppressing global interest rates. The post-Covid era has brought an end to QE, and some central banks (e.g., the US Federal Reserve (Fed)) are currently selling bonds, the reverse policy of QE (otherwise known as quantitative tightening).

Without QE to suppress bond yields, we would expect R* to drift higher and to be closer aligned to the overall rate of income growth in the economy. Our current of estimates of R* for the fed funds rate is slightly higher than 3% (cf the Feds current guidance of close to 2.5%), while our estimate for the RBA’s cash rate R* is closer to 3.8% than the RBA’s current estimate of 3.5%.

A higher R* has two potential impacts on the path of interest rates. First, for any given level of the actual interest rate, a higher R* means that the policy rate is less restrictive. Second, as the central bank begins its easing cycle, the target to which the rates are converging is higher than previously thought. Both impacts lead to a higher yield structure in the post-Covid era relative to the pre-Covid decade.